US Agency Market 2010 and Beyond

California Municipal Treasurers AssociationApril 21, 2010

The materials may not be used or relied upon in any way.

CONFIDENTIAL

Ivan Hrazdira, Managing Director

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Fannie Mae:Total Debt Outstanding: $785.8bn as of Feb 28, 2010Total Long Term Debt Outstanding: $581.6Total Long Term Issuance: $52.4Total Net Long Term Issuance: ($3.5)

Freddie Mac:Total Debt Outstanding: $833.3bn as of Mar 31, 2010Total Long Term Debt Outstanding: $596.2Total Long Term Issuance: $111.2Total Net Long Term Issuance: $16.9

FHLB:Total Debt Outstanding: $870.9bn as of Mar 31, 2010Total Long Term Debt Outstanding: $682.7Total Long Term Issuance: $148.4Total Net Long Term Issuance: ($49.4)

Farm Credit: Total Debt Outstanding: $173.3bn as of Mar 31, 2010Total Long Term Debt Outstanding: $163.8Total Long Term Issuance: $24.5Total Net Long Term Issuance: ($0.7)

Agency Market Stats

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Pro:

Sidelined overseas investors have returned to the market

Relatively low global rates will make spread product appealing

Government has stressed a solid backing of the GSE credit

through PSPA

Our base case scenario is for swap spreads to tighten

Con:

GSE Supply in short term will be higher than the market was

anticipating

“Legislative orphans”

Higher rates may bring in convexity paying in swaps

Our Outlook on Spreads

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Preferred Stock Purchase Agreement

Preferred Stock Purchase Agreement

The mechanism whereby the US government backstops the debt and mortgages of Fannie Mae and Freddie Mac

Announced on Sept 7th, 2008. Is part of conservatorship“Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and stability to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities.”

Initial amounts were $100bn each; later increased to $200bn each.

So far, Fannie Mae has drawn on $76bn and Freddie Mac has drawn $51bn. Freddie Mac has not drawn any capital for two quarters.

0

20

40

60

80

100

Liabilities Assets0

20

40

60

80

100

Liabilities Assets

IF:

> (incl. principal and interest payments)

Then:

Government injects amount of capital to make up for shortfall

New injection takes form of preferred stock, which pays the government a 10% dividend

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“Under the Agreements, following a payment default by a GSE with respect to any Holders, and in the event Treasury fails to perform its obligations to either of the GSEs in respect of any draw on the Commitments, those Holders may file claims in the United States Court of Federal Claims for relief requiring Treasury to pay the relevant GSE a specified amount (called "the Demand Amount") in the form of liquidated damages. After consultation with the Civil Division of the Department of Justice, we conclude that the United States Court of Federal Claims generally would have jurisdiction under the Tucker Act to entertain claims brought by the Holders for liquidated damages, payable to a GSE, according to the terms of the Agreements, if Treasury failed to perform its obligation under the Agreements to fund the Commitment in the event of a payment default by the GSE to the Holders”

Department of Justice Ruling on PSPA

Source: US Department of Justice Office of Legal Counsel – Letter from the DOJ to

Treasury

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Among non-US accounts, strong opinions on FHLB

Europe vs. Asia vs. Asia

Among US investors, FHLB / Fannie / Freddie are fungible

What drives a customers decision to buy a particular name?

Flexibility

Cost

Tax Advantage

Liquidity

The Future

Investor Behaviour

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Changes in Investor Participation

1915 19

16 3224 29

31 2135

1726

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100

120

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

500

1000

1500

2000

2500

3000

3500

US Asia Europe Other Federal Agency Securities

Source: Fannie Mae

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Lessons Learned:

Loose underwriting led to the housing debacle

ARMs created more problems than they solved

Excessive leverage prevented the GSEs from being effective backstops

Implicit guarantee and conflicting mandates encouraged GSE risk taking

New entities must have robust capital standards/leverage ratio limits to minimize systemic risk

What will happen to mortgage finance now?

What the Government will now want:

An appropriately functioning three tiered system to service all homeowners:

FHA for lower income

GSEs/successors for lower/middle income

Private label for jumbo mortgages

Protect the taxpayer

Support 30yr fixed rate mortgage and TBA market

Make implicit guarantee explicit in a cost effective way

Require GSEs to be overcapitalized to not only withstand loss but also operate even after a catastrophic loss

A model that is more sustainable than the Fed b/s

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FNMA & FHLMC

FNMA FHLMC

FHLMCFNMA

Currently:

2010:

2011 and Beyond:

New World:

• Covered Bonds

• Little or no government involvement

• Fannie/Freddie wound down

Government Guaranteed

• An entity backed by the government in the business of packaging MBS that meet certain criteria; broader FHA

Successor Entities Providing

Guarantees • Hybrid ownership

• Utility model regulated returns

•Private Capital, with government providing catastrophic loss backstop

AS IS

Probability: Low Medium HighLow

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Will very likely remain in some form as part of the new structure of mortgage finance. Here’s Why: Know how and technology The ability to act as a buyer of last resort The entrenched, efficient nature of the TBA market

Biggest question is what will happen to the portfolios? Very contentious issue Not the cause of huge losses Any future role for portfolios would have to be mission consistent and meet

funding hurdles

In almost any scenario, the portfolios will shrink significantly

What will happen to Fannie and Freddie

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The dissolution of Fannie and Freddie

Implicit vs. Explicit

The rise of Supras and Sovereigns

Covered Bonds

Libor spike

“FDIC Risk”

Removal of Superlien

Taxing FHLB System

Threats to FHLB Market

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What’s the Outlook for Agency Supply?

Source: Companies and/or their websites

Net Issuance (long term debt)

146

48

438

1231

0

69

14

-41 -39-18

36

105

5618

-1

-78 -75

242

180

76

-63-45

-12

-60-26-42

153527

60 3763 53

123

-200

-150

-100

-50

0

50

100

150

200

250

300

Freddie Fannie FHLB Total

2002 2003 2004 2005 2006 2007 2008 2009 2010 projected

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The Supra/Sov Market

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Prorata

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100

120

140

160

180

200

Deal Value $ (Face) (m) No.

Deal Value $ # of Deals

Source: Credit Suisse

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Trades We Like – Fixed to Float

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Fixed to Float Trades

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0 1 2 3 4 5Years

Rat

e (%

)

3-month Libor Fwd Curve

1yr Fixed @ 1% w/ 5% Cap

This is a hypothetical bond with a 1% coupon for a year, that converts to floater thereafter at 3ML+50

Bond is callable quarterly after first 3 months

This graph reflects hypothetical returns if forwards are met

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Various outcomes for Fixed - Float: A Simplistic AnalysisWhat Happens Result Comparable

Inv.P/L

Bond gets called in 3 months

Bond gets called in 1year

Bond does not get called

Bond does not get called and hits the cap

Make 1% for 3 months

Make 1% for 1 year

Make 1% for 1yr, then L+50 until call or maturity

Make 1% for 1yr then L+50, capped at 5%

Discount Note at 0.18%

One year bullets yield 0.58%

5yr floater issued by GSEs would likely yield about L+10

5yr floater issued by GSEs would likely yield about L+10

Outperform alternative

Outperform alternative

Outperform alternative

Underperform alternative

These outcomes are not conclusive but are broadly representative. There are many possible outcomes

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Investors interest in agencies remains robust

However, the future is highly uncertain

Although legislative change will come slowly, it will

happen

Alternatives to GSE market are real

Great trades out there to take advantage of Fed forecasts

Key Takeaways